Wednesday, August 31, 2016

I have spent a lot of time in these pages writing about the influence of macro-economic factors on market analysis. Indeed, Matt King at Citigroup recently highlighted the growing importance of macro factors on the equity market (chart via Bloomberg):

Here are three key macro factors that I have been watching now for clues to the direction of the stock market and sector selection.

Tuesday, August 30, 2016

Mid-week market update: In the wake of Federal Reserve vice chair Stanley Fischer's remarks about Friday's Job Report, the market is mainly playing a waiting game for the results of that announcement. However, there are signs that the Jobs Report may be setting up for a negative surprise which could be bullish for bond and equity prices and bearish for the USD.

Monday, August 29, 2016

In my last post (see The roadmap to a 2017 market top) I wrote that one possible bear market trigger would be a debt crisis in China. In response, an alert reader sent me this Bloomberg tweet and asked for my comment.

How bad could a China debt crisis get? In this post, I try to model the global effects of a China hard landing.

Sunday, August 28, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Risk-on*

Trading model: Bullish*

The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

A 2017 market top?
I don't want anyone to get the idea that I am a permabull. I have been steadfastly bullish on stocks for all of 2016. This may be the time to sound a cautionary note by outlining a scenario of how stock prices could make a cyclical top next year.

The chart below shows how the stock market behaves during the four-year presidential cycle. The black line shows the pattern based on past monthly median returns and the blue line shows the pattern based on average monthly returns. Statistically, median returns (black line) are better representations than average returns (blue line) because averages can be distorted by large outliers, such as the Crash of 2008.

The stars may be aligning for a replay of the presidential cycle, where stock prices rise into next year and possibly top out next summer. In this week's post, I will discuss:

The bullish tailwinds prevailing for stocks today

The timing of a possible cyclical peak

The bearish headwinds that could lead to the formation of the market peak.

Thursday, August 25, 2016

The markets have been nervous as we await Janet Yellen's speech at Jackson Hole. Now that the agenda for the Jackson Hole symposium has been released, I believe that Yellen is unlikely to announce any major shift in monetary policy in her speech.

The intent of the Jackson Hole symposium is for Federal Reserve officials to think long term. The intent isn't to make a decision on whether to raise interest rates in September, December, or next year. Instead, the purpose of the meeting is to think about different frameworks for Fed officials to do their job. Possible topics include the conduct of monetary policy and their mechanisms, financial regulation, and so on.

Three camps at the Fed
If Yellen did indeed want to signal a philosophical focus in the conduct of monetary policy, then the logical course of action is to allow one or more academics to present research in support of such a shift. Ostensibly, the presentation would be for discussion purposes only, but the real intent would be to create sufficient buzz to change how the discussion could be framed at future FOMC meetings. I had been watching the agenda for some hints that Yellen could find herself shifting her opinion towards one of three camps at the Fed:

Wednesday, August 24, 2016

Mid-week market update: On the weekend (see The market's hidden message for the economy, rates and stock prices), I wrote that the short-term outlook was more difficult to call than usual. On one hand, we were seeing broad based strength, which argued for an intermediate term bullish call. On the other hand, Urban Carmel pointed out that the market has a tendency to pause when it nears a round number. In this case, the hurdle is 2200 on SPX.

The latter scenario seems to be winning out. The market is catching a case of round number-itis for the following reasons:

Macro momentum became "overbought";

Overly bullish short-term sentiment; and

Deteriorating short-term breadth.

I would caution that this is purely a tactical call of a short-term SPX correction of no more than 3-5%. As I wrote two weeks ago: Be patient, it's hard to argue against the intermediate term bullish trend.

Tuesday, August 23, 2016

About three weeks ago, I wrote about opportunities in European equities (see Worried about US equities? Here's an alternative!). I pointed out that stock prices in Europe were far cheaper than US, the fears about European integrity and financial system were overblown, and the market seemed to be ignoring signs of a growth recovery.

Since then, the FTSE 100 has moved to new recovery highs since the Brexit vote.

The Euro STOXX 50 has rallied through a downtrend resistance level and it's has retreated to test support.

American investors can see a similar pattern on the USD denominated ETF (FEZ).

If you missed the first opportunity to buy into Europe, this may be your second chance.

Sunday, August 21, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Risk-on*

Trading model: Bullish*

The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

The message from inter-market analysis
I have always believed in listening to the markets. Technical analysis is useful as it can be a way of discerning the market's hidden message, especially when performing inter-market analysis, otherwise known as cross-asset analysis.

I have found point and figure charts to be particularly useful tools because they filter out a lot of the price noise, especially when markets trade sideways in a tight range as they have recently. As an example, my recent post that featured a SPX weekly point and figure chart got a lot of attention (see Be patient). Since I performed that analysis, not much has changed. The latest weekly chart pattern remains unambiguously bullish on an intermediate term basis. It also tells the bullish story of powerful price momentum, TINA (There Is No Alternative) and FOMO (Fear Of Missing Out), all rolled into one.

I reviewed my charts using this technique in order to get a fresh point of view and what I found astonished me. Over and over again, I was getting a lot of chart patterns like this from a single market sector.

Bullish or bearish? The charted instrument is in a well-defined uptrend, but there is overhead resistance nearby. While I interpreted it bullishly, I wanted to be sure. A Twitter poll showed that the crowd agreed with me.

This results of this analytical approach was in effect a hidden message from Mr. Market. More importantly, the message has crucial medium term implications for the economy, interest rates, stock prices, and the likely trajectory of Fed policy.

Wednesday, August 17, 2016

Mid-week market update: The intermediate term outlook that I've been writing about for the past few weeks hasn't really changed (see Get ready for the melt-up and Party like it's 1999, or 1995?). The stock market continues to enjoy a tailwind based on the combination of overly defensive investors and a growth turnaround which is leading to a buying stampede.

The Dow, SPX and NASDAQ made simultaneous new all-time highs (ATHs) on Friday, August 5, 2016 and repeated that feat again this week on Monday, August 15, 2016. Ryan Detrick of LPL Research pointed out that such events tend to be bullish. The chart below shows past instances of simultaneous new highs.

The table below details stock market performance after such events. Current circumstances are consistent with my buying stampede thesis.

However, it is not at all unusual for stock prices to trade sideways after breakouts to ATHs. As long as the consolidation action is benign, the path of least resistance is up. The minor market weakness in the last couple of days is also consistent with my view of sideways consolidation.

Tuesday, August 16, 2016

As we await the Fed`s annual Jackson Hole symposium on August 25-27, Bloomberg highlighted a research paper by Fed economist Jeremy Nalewaik. Nalewaik found that inflation and inflationary expectations had tracked each other well but started to diverge in the mid 1990's.

This paper is important to the future of Fed policy, as it pushes the Fed towards a lower for longer view where inflationary potential is far lower than previously expected:

“Movements in inflation expectations now appear inconsequential since they no longer have any predictive content for subsequent inflation realizations,” Nalewaik wrote.

He cites as a potential explanation for this a hypothesis offered in a 2000 paper co-authored by Yellen’s husband, Nobel prize-winner George Akerlof, who wrote that “when inflation is low, it may be at most a marginal factor in wage and price decisions, and decision-makers may ignore it entirely.”

Akerlof’s and Nalewaik’s research jibe nicely with ideas that St. Louis Fed President James Bullard has injected into the debate on the rate-setting Federal Open Market Committee this year.

If this paper becomes a major focus at the Jackson Hole meeting, then the Fed is likely to tilt towards a take-it-slow view on raising interest rates. However, I would argue that this analytical framework is highly sensitive to how the Fed picks its input variables. One wrong move could result in a policy error of major proportions.

Sunday, August 14, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Risk-on*

Trading model: Bullish*

The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

How close are we to a market top?
I am used to getting abused for my market views, but the abuse is starting to turn into agreement - and that's a cautionary flag. I haven't always been a bull, here is a summary of my major market calls since January 2015.

Now that the broad market averages are seeing new all-time highs, market psychology has shifted from skepticism to grudging acceptance of the bull case. This got me worried. Am I becoming consensus and part of the crowd? Does this mean that the market is about top out?

For some perspective on this question, the Dow, SPX and NASDAQ all made simultaneous new highs last Thursday. The last time this happened was December 31, 1999, which was shortly before the ultimate top in March 2000, indicating that the market may be in a high risk zone. On the other hand, Ryan Detrick highlighted analysis showing simultaneous new highs in all three indices tend to be bullish.

Coincidental new highs is reflective of bullish price momentum, Detrick pointed out that the market saw a total of 25 simultaneous new highs in 1995.

So should we party like it's 1995, which was a sustained bull move, or late 1999, which marked a blow-off top?

I believe that the answer depends on the timing of a recession caused bear market, which is a function of the Federal Reserve's reaction to economic and market developments.

Tuesday, August 9, 2016

I am seeing an unusual level of rising anxiety over the political implications of Brexit. Last week, Stratfor published a report entitled "Brexit: The First of Many Referendum Threats to the EU", which detailed the threats of additional referendums to the future of Europe.

Jim Rogers, writing in the Daily Reckoning, also painted a dire picture of the world after Brexit:

Are we at a point right now where it feels like it’s accelerating. People all over are very unhappy about what’s going on. If you read history, there are a lot of similarities between now and the 1920s and ’30s. That’s when fascism and communism broke out in much of the world. And a lot of the same issues are popping up again.

Brexit could be a triggering moment. This is another step in an ongoing deterioration of events. It’s also an important turning point because it now means the central banks are going to print even more money. That may prop the markets up in the short term...

The European Union as we know it is not going to survive. Not as we know it. Britain voted to leave, and France could very well be next. Why France? One of the main reasons is because the French economy is softer than the German economy. At least in Germany people are still earning money and making a living, despite all the recent turmoil. In France, the same malaise that’s settling over the U.S. and other places is settling in. And it’s going to spread.

There is no place to hide with what’s coming. I’m not saying it’s coming this year, or even the next. I can’t give a specific date. But imbalances are building up to such a degree, they just can’t continue much longer.

In addition, Philippe Legrain fretted about Brexit opening the door to European disintegration in an essay in Project Syndicate.

I beg to differ. In fact, the Brexit experience has made Europe stronger, not weaker.

Sunday, August 7, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Risk-on*

Trading model: Bullish*

The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

A global growth rebound
The SPX broke out to another all-time high on Friday in response to the positive surprise from the Employment Report. The upside breakout followed a false breakdown out of a narrow trading during the same week. The key question for traders is, "Is this an honest-to-goodness breakout, or just a fake out?"

Indeed, there is an intermediate term bullish case to be made. I've been writing for the past few weeks about how the combination of overly defensively oriented investors and a US growth surprise is leading to a FOMO (Fear of Missing Out) rally in US equities. Now it seems that the growth surprise is spreading around the world. As the chart below shows, the Global Purchasing Managers Index (PMI) is turning up, which is a positive sign for global growth.

On the other hand, short-term technical indicators are flashing signals of extreme caution. The market appears to gotten ahead of itself and a pullback may be in order before stock prices can rise sustainably. The chart below from Sentiment Trader shows that sentiment is at an optimistic extreme, which is a worrisome sign (annotations in red are mine).

Wednesday, August 3, 2016

Mid-week market update: After spending over two weeks in a narrow trading range, the SPX broke down out of that range yesterday and tested technical support at the 20 day moving average (dma), which was also the mid-Bollinger Band mark. At the height of the decline, the index had fallen 1% and the market was flashing short-term oversold signals.

When the market steadied soon after the open on Wednesday, I tweeted:

It appeared that the market had successfully tested 20 dma support:

In addition, short-term breadth measures (via IndexIndicators) had retreated to oversold levels that a bounce was likely.

Those conclusions are based on the combination of an intermediate term backdrop of economic and fundamental growth and powerful price momentum. Under such circumstances, market pullbacks are likely to be shallow and further all-time highs would probably follow soon afterwards.

Valuation metrics for European stocks are certainly cheaper. The SP 500 trades at a price to book ratio of 2.7 and forward P/E 18.4. By contrast, FTSE Europe trades at a P/B of 1.6 and forward P/E of 15.9 and the Euro Stoxx 50 trades at a P/B of 1.3 and forward P/E of 13.5.

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Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

DISCLAIMERThis is not investment advice! I know nothing about you, your risk preferences, your portfolio or your investment horizon. I have no idea whether any of my opinions expressed are suitable for you.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. I may hold or control long or short positions in the securities or instruments mentioned.